Recent research by Goldman Sachs revealed US investors have directed more money towards European equities than at any other time since 1977. Pension funds and other institutional investors have taken the nascent recovery in the eurozone economies as a reason to invest around $65bn in European stocks since the start of the year, the firm found.
The popularity of European funds has also been reflected in the soft-closure of Alistair Hibbert’s BlackRock European Dynamic Fund, announced last week. BlackRock intends to hike the initial charges on the fund in order to stem flows. At the same time, it hard-closed a number of its Luxembourg-domiciled alpha strategies, which had reached over $1bn in size.
The question for wealth managers is whether they should follow this trend. Certainly the economic backdrop in Europe appears to be more favourable that it has for some time. In August, Eurostat announced the eurozone had emerged from recession after a record 18 months of economic contraction. Buoyed by stronger figures from Germany and France, overall GDP for the bloc grew by 0.3% in the second quarter of 2013. Since then, retail sales figures and manufacturing data have also been ahead of expectations. It may not be strong, but any sign of recovery in Europe is a bonus when expectations have been so low.
Equally, as investors have sought to adjust their portfolios for economic recovery, they have plumped for Europe rather than emerging markets. This is partly because the economic data released from many emerging markets is still weak, but also because valuations simply looked more compelling in Europe. Patrick Moonen, Senior Strategist Multi Asset at ING Investment Management said European equities are as much as 15% undervalued compared to their international peers in price to earnings terms.
Certainly, in spite of the weight of money moving towards European equities, there has been no notable outperformance to date. The Europe ex UK sector is the 11th best performing sector since the start of the year, respectable, but not impressive. The average fund is up 16.6%, compared to 18% for the UK Equity Income sector or 24.1% for the North America sector. Also, US investors may have warmed up towards the sector, but European investors remain relatively cool: the latest statistics from Morningstar show no notable flows into European funds, with investors preferring US and Global Equity Income-focused funds.
Moonan said there has certainly been a change in sentiment towards European equities since the start of the summer, but ‘one swallow does not make a spring’. He added: "Earnings growth has troughed and we expect acceleration in the second half of the year and into 2014. Taken into account the high sensitivity of European earnings to even a small improvement in revenues, we expect margin expansion and double-digit earnings growth next year provided the global growth environment remains benign. To make the picture even more compelling, this earnings growth does not come at a high price. The price earnings ratio of European companies is 15% below the global average. Relative to the US market, the discount is 35%, close to historic highs."
While these are all reasons that valuations may not yet have over-reached themselves, it should be remembered that there are still a number of concerns surrounding Europe. War in Syria may derail any nascent appetite for risk among investors, which could hit European markets disproportionately hard. Equally, if there are any surprises in the German elections, it would unsettle markets. Nevertheless, the discount to other global markets looks overdone and if US buyers continue their interest, the region could well see the uptick we have been waiting for.
